Class Action Claims Alleging Securities Exchange Act of 1934 § 10(b) and Rule 10b-5 Violations Against Customers and Suppliers of Charter Communication for Allegedly Aiding Charter’s Scheme to Publish Misleading Financial Statements Properly Dismissed because Class Action Plaintiffs-Investors did not Rely on any Representations by Customers/Suppliers U.S. Supreme Court Holds
Plaintiffs filed a class action lawsuit against Charter Communications and others, including Scientific-Atlanta and Motorola as customers and suppliers of Charter Communications, alleging securities violations under § 10(b) of the Securities Exchange Act of 1934 (the Act) and SEC Rule 10b-5; specifically, the class action alleged that the customers/suppliers “agreed to arrangements that allowed the investors’ company [Charter Communications] to mislead its auditor and issue a misleading financial statement affecting the stock price.” Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., ___ U.S. ___, 128 S.Ct. 761, 2008 WL 123801, * 2 (January 15, 2008). Defense attorneys for Scientific-Atlanta and Motorola moved the district court to dismiss the class action complaint against them for failure to state a claim, and the court granted the defense motion. Id., * 4. Plaintiffs’ appealed, and the Eighth Circuit affirmed concluding, “the allegations did not show that [Scientific-Atlanta and Motorola] made misstatements relied upon by the public or that they violated a duty to disclose,” id. The Supreme Court granted review of this issue, critical to numerous class actions pending throughout the country, to “consider the reach of the private right of action…implied in § 10(b) [of the Act]…and SEC Rule 10b-5.” Id., at *2. The High Court affirmed the Eighth Circuit’s decision.
The class action complaint alleged that Charter Communications, a cable operator, “engaged in a variety of fraudulent practices so its quarterly reports would meet Wall Street expectations for cable subscriber growth and operating cash flow.” Stoneridge, at *3. As the Supreme Court explained at page *3; “The fraud included misclassification of its customer base; delayed reporting of terminated customers; improper capitalization of costs that should have been shown as expenses; and manipulation of the company’s billing cutoff dates to inflate reported revenues.” The theory underlying the class action claims against Scientific-Atlanta and Motorola was that in 2000, after Charter realized that it would miss cash flow estimates by $15-$20 million despite the fraud described above, Charter altered its arrangements with Scientific-Atlanta and Motorola in an effort to mislead Arthur Andersen: specifically, “Respondents [Scientific-Atlanta and Motorola] supplied Charter with the digital cable converter (set top) boxes that Charter furnished to its customers. Charter arranged to overpay respondents $20 for each set top box it purchased until the end of the year, with the understanding that respondents would return the overpayment by purchasing advertising from Charter. The transactions, it is alleged, had no economic substance; but, because Charter would then record the advertising purchases as revenue and capitalize its purchase of the set top boxes, in violation of generally accepted accounting principles, the transactions would enable Charter to fool its auditor into approving a financial statement showing it met projected revenue and operating cash flow numbers.” Id. Scientific-Atlanta and Motorola allegedly agreed to this arrangement, and participated in drafting documentation “to make it appear the transactions were unrelated and conducted in the ordinary course of business.” Id. Neither Scientific-Atlanta nor Motorola played any role “in preparing or disseminating Charter’s financial statements,” and both of them “booked the transactions as a wash, under generally accepted accounting principles.” Id., at *4.
The Eighth Circuit affirmed the district court order dismissing the class action claims against Scientific-Atlanta and Motorola in part because the allegations of the class action complaint established at most acts of aiding and abetting, but “there is no private right of action for aiding and abetting a § 10(b) violation.” Stoneridge, at *4 (citation omitted). The Supreme Court granted certiorari because circuit courts disagreed as to “when, if ever, an injured investor may rely upon § 10(b) to recover from a party that neither makes a public misstatement nor violates a duty to disclose but does participate in a scheme to violate § 10(b).” Id. (citations omitted).
In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), the Court held that § 10(b) liability did not extend to aiders and abettors because that would permit defendants to be found liable “without any showing that the plaintiff relied upon the aider and abettor’s statements or actions” and “[a]llowing plaintiffs to circumvent the reliance requirement would disregard the careful limits on 10b-5 recovery mandated by our earlier cases.” Central Bank, at 180. The Supreme Court reaffirmed this holding, stating at page *6: “The § 10(b) implied private right of action does not extend to aiders and abettors. The conduct of a secondary actor must satisfy each of the elements or preconditions for liability[.]” The Supreme Court’s analysis led to the same conclusion reached the by Eighth Circuit, viz., “that any deceptive statement or act respondents [Scientific-Atlanta and Motorola] made was not actionable because it did not have the requisite proximate relation to the investors’ harm.” Stoneridge, at *6.
The High Court rejected plaintiffs’ “presumption of reliance” argument, Stoneridge, at *6, “scheme liability” argument, id., at *7, and “common-law action for fraud” argument, id., at *8. The Court also noted that in response to Central Bank Congress enacted the PSLRA which amended the securities laws so as to permit the SEC to bring aider and abettor claims, but not private parties. Id., at *8-*10. As the Supreme Court concluded at page *11, “Here respondents [Scientific-Atlanta nor Motorola] were acting in concert with Charter in the ordinary course as suppliers and, as matters then evolved in the not so ordinary course, as customers. Unconventional as the arrangement was, it took place in the investment sphere. Charter was free to do as it chose in preparing its books, conferring with its auditor, and preparing and then issuing its financial statements. In these circumstances the investors cannot be said to have relied upon any of respondents’ deceptive acts in the decision to purchase or sell securities; and as the requisite reliance cannot be shown, respondents have no liability to petitioner under the implied right of action.” Accordingly, it affirmed the decision of the Eighth Circuit, id., at *12.
NOTE: This decision was not unanimous. Justice Stevens dissented, joined by Justices Souter and Ginsburg.